Ep.59- Financially Speaking: Winter Is Coming
Read Time: 3 Minutes.
It's a strange economy in America. While all the indicators suggest the economy is in its best shape since the Great Recession, yet most of us don't really feel it. Supposedly, our economy grew faster than expected in Q1, and the unemployment rate dropped to 3.9%, an 18-year low.
BUT...at the same time, many of us don't feel the benefit of a "booming" economy in a tangible way. Companies struggle to turn a profit. Students struggle to get out of debt. Young adults struggle to buy their first house. As a matter of fact, the real household median wage has not increased for two decades since 1999.
How can we struggle so much if the economy is so great?
MOST TECH COMPANIES HAVE NEVER BEEN PROFITABLE
Modern tech companies have adopted the strategy of pursuing user growth first, revenue second, profitability third. Because of this strategy, the average person has benefited immensely, as these companies make goods/services more accessible and affordable.
Just to name a few, Uber and Lyft helped cut taxi costs to a fraction of the costs. Twitter has helped spark many movements. Yelp has helped me make so many decisions free of charge. BuzzFeed has provided me with hundreds of hours of quality entertainment in the past few years. MoviePass also helped me justify going to the movies again with its ultra-affordable price.
These companies all have one thing in common: None of them makes a profit. Wait, there are more of them: Sprint, Spotify, Snapchat, Box, and Dropbox also have never made a profit.
If these companies don't make a profit, how can they stay in business? Great question! In short, through subsidies from investors. MoviePass is possibly the epitome of all. Slate described the business model of MoviePass as “creatively lighting money aflame in order to subsidize the movie-going habits of some 3 million customers.” Beautifully said indeed.
MOVIEPASS COULD BE THE CATALYST TO A TECH BUBBLE
By the time this article is published, MoviePass may already be out of business (personally I hope not, as I have paid for the full year). The effect of its downfall may spook future investors (more so in the shadow economy instead of the traditional banks), which in turn could clog liquidity for future investments for any company that needs another round of funding.
Let's use Uber as an example. In 2017, Uber lost $4.5 billion dollars on a revenue of $7.5 billion, a scale that's hard to comprehend. What would happen to our economy if Uber needs another round of investment of $1 or $2 billion? Who is going to be willing to fund it?
A FAMILIAR PATTERN TO THE DOT-COM BUBBLE:
UNPROFITABILITY, RISING INTEREST RATES, AND SEEMINGLY FULL EMPLOYMENT
Where we are today is alarmingly similar to the dot-com bubble in these three areas: most tech companies struggle to be profitable, interest rates are rising, and unemployment is ultra-low.
Struggle to Be Profitable: According to the New York times, "Over all, 76 percent of the companies that went public last year were unprofitable on a per-share basis in the year leading up to their initial offerings, according to data compiled by Jay Ritter, a professor at the University of Florida’s Warrington College of Business." That was the largest number since the peak of the dot-com boom in 2000, when 81 percent of newly public companies were unprofitable.
Rising Interest Rates: Leading up to the dot-com bubble, the Fed Funds Rate was raised from a low of 4.75% in Q2 1999 to 6.5% in Q3 2000. In less than a year, it went up by 1.75 percentage points. For that reason, easy money quickly became expensive. The bubble then burst half a year later, in Q1 2001. What about now? As of May 2018, the Fed Funds Rate has risen from 0.45% in Q4 2016 to 1.45% in Q1 2018, by 1 percentage point. It is expected to increase further. In other words, liquidity may slow down, as easy money won't be as easy to come by.
Ultra-Low Unemployment: Before the dot-com bubble, the unemployment rate dipped below 4.5% for 38 months straight, starting from April 1998, ending with the bubble in June 2001 . Currently, we have experienced 13 months of unemployment rate that's under 4.5%, including April dipping below 4%, which is rare by historical standards. It can be argued that this cannot be sustained. If history is any sign, maybe we can expect to see a tech bubble pop in two years.
If what I speculate will come true in the next 2-5 years, I would strive to save as much as possible now, so I could have a cushion when the storm comes. In the meanwhile, I would enjoy the benefits of subsidized services provided by these tech companies, as long as they have not burned through their funding. Cheers!
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